NEWS
12 May 2022 - One of the ASX's most impressive stocks
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One of the ASX's most impressive stocks Airlie Funds Management April 2022
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In the search for high-quality businesses that are undervalued, one of the richest hunting grounds is a 'jewel in the crown' scenario, whereby a great business is hidden within a languishing conglomerate. One of Airlie's core holdings, Tabcorp (TAH.ASX), presents such an opportunity, operating a high-quality Lottery division whose stellar performance has historically been overshadowed by a structurally challenged Wagering division. Fortunately for shareholders, Tabcorp management have made the astute decision to demerge this 'jewel' into a new listed vehicle, The Lotteries Corporation. Whilst this process has already served to unlock material value for shareholders, we believe the market continues to undervalue the infrastructure-like qualities of this Lotteries division. The Lottery Corporation (Lotteries & Keno) In Australia, Lottery licences are awarded exclusively on a State-wide basis, with Tabcorp currently holding all State licences bar Western Australia (operated by the WA Government). These state-based monopolies exhibit very similar traits to infrastructure concessions; licences are typically long-duration (ranging from 10 to 40yrs in length), demand for the product is insensitive to economic cycles, feature strong pricing power, and offer very dependable and predictable cash flows. However, lottery concessions are far less capital intensive than their typical infrastructure counterparts. In fact, we estimate that Tabcorp's Lotteries division generates a return on invested capital north of 50%! The crucial factor for a concession operator is whether future licences can be renewed on attractive terms. For lottery concessions specifically, there are some important aspects that heavily favour the incumbent during the bidding process. The most obvious of these being the benefit of scale; Tabcorp are the only private operator of Lottery licences in Australia. This means that any fixed costs related to technology, systems and processes can be shared across the various State licences, resulting in higher profit margins. Given these economies of scale, Tabcorp can operate any individual licence more profitably than a new entrant and thus the company can bid a higher price for that licence. Continuity is also an important consideration during the bidding process. The State Government issuing the licence generates material tax revenue based on the value of lottery tickets sold. Any new entrants would need to replicate Tabcorp's existing retail network, customer lists, infrastructure, systems and processes whilst ensuring no drop in turnover (and tax revenue) for that respective State Government. These State Governments are larger stakeholders in the Lottery operations than even Tabcorp itself; over just the last 3 years, the Lotteries segment has paid over $5.1bn in State taxes, dwarfing Tabcorp's own estimated profits of <$1bn. It is clearly in the best interest of the various State Governments to maximise the turnover performance of the Lotteries licences rather than attempt to squeeze extra margin by switching operator. The only material upcoming licence renewal is the Victorian Lottery licence in 2028. Interestingly, whilst Victoria is one of the highest lottery turnover States, it is also one of the lowest margin licences given the State's higher lottery tax rate. Back in 2012 when Tabcorp acquired the South Australian Lottery licence, they disclosed Victoria's 'operator margin' at 3.9%, compared to 9.2% and 10.5% for NSW and QLD respectively. Importantly, any new entrant seeking to gain material scale in the market would need to wait until 2050 for the opportunity to bid on the NSW licence. Tabcorp has lost a portion of the Victorian licence before, when Intralot were awarded the instant scratchies portion of the licence back in 2007. However, after 6yrs of operation and a reported $63m in losses, Intralot forfeited the licence and it was awarded back to Tabcorp. Due to these structural advantages, Tabcorp's Lotteries & Keno business has one of the most impressive track records of any listed ASX business, growing earnings before interest and tax (EBIT) at a compound annual rate of 9% over the last 10 years. As impressive as this track record appears, the earnings momentum here is actually understated; during the Tabcorp/Tatt's merger in 2018, $65m in costs were reallocated to the Lottery segment, negatively impacting earnings. As can be seen in the chart below, this change in accounting policy had the effect of materially reducing profit margins in FY17 despite having nothing to do with the fundamental performance of the business. Margin expansion has driven much of the segment's historical growth in earnings, but importantly there are several reasons to believe this can continue; (1) continued economies of scale as the company's fixed costs are spread across a larger revenue base, (2) increasing digital penetration which avoids the ~10.3% commission paid to newsagents, and (3) the superior terms recently negotiated with lottery reseller Jumbo Interactive (JIN.ASX). The new Tabcorp (Wagering, Media and Gaming Services) The remaining Tabcorp stub will include the Wagering, Media and Gaming Services businesses. The lion's share of value here is in the Wagering & Media operations. Under the TAB brand, Tabcorp holds the exclusive licence to conduct wagering operations in retail venues across all Australian States and Territories excluding Western Australia. This retail monopoly is facing structural disruption as punters increasingly elect to bet with online bookmakers such as SportsBet, Ladbrokes and Bet365. Whilst Tabcorp have their own online channels, these digital-first competitors offer superior customer functionality, products and branding, as well as enjoying structural opex and tax advantages. The earnings track record of the Wagering & Media business reflects these difficulties. But there are glimmers of hope emerging; Tabcorp now generates over $9bn in digital wagering turnover, representing around 55% of total wagering turnover for the group. On a digital-only basis, Tabcorp is the second largest player in the market, with a 21% share of turnover. Furthermore, recent regulatory changes have helped to level the playing field between Tabcorp and its online competitors by reducing structural tax disadvantages. Clearly other interested parties see value here; Tabcorp has received multiple bids within the last year valuing the Wagering & Media business at $3.5bn ($4bn including the Gaming Services business). Whilst there are significant impediments to completing a transaction (change of ownership provisions and racing body approvals), this does give some indication of the underlying value within the segment not reflected in the current earnings momentum. Valuation: If we ascribe a valuation of $3bn to the Tabcorp stub (a material discount to the recent $4bn bid from Apollo Global Management), we get an implied earnings multiple for The Lottery Corporation of 19x FY22 EBIT. This reflects a 24% premium to the median EV/EBIT of the ASX300 ex-financials and resources. However, on a normalised cash flow basis - adjusted for return on capital employed - The Lottery Corporation is trading about in line with the market despite its superior growth outlook. As can be seen in the table below, the company also compares favourably on a number of metrics to listed toll toad concession operators, Transurban and Atlas Asteria. For this reason, despite the strong share price performance, we continue to see material upside in this core holding. Author: Will Granger, Airlie Investment Analyst Funds operated by this manager: Important Information: Units in the fund(s) referred to herein are issued by Magellan Asset Management Limited (ABN 31 120 593 946, AFS Licence No. 304 301) trading as Airlie Funds Management ('Airlie') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation. This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au. Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements. This material may include data, research and other information from third party sources. Airlie makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Airlie. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. Any third party trademarks contained herein are the property of their respective owners and Airlie claims no ownership in, nor any affiliation with, such trademarks. Any third party trademarks that appear in this material are used for information purposes and only to identify the company names or brands of their respective owners. No affiliation, sponsorship or endorsement should be inferred from the use of these trademarks.. This material and the information contained within it may not be reproduced, or disclosed, in whole or in part, without the prior written consent of Airlie. |
12 May 2022 - Big Player - Investment Snapshot
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Big Player - Investment Snapshot Insync Fund Managers April 2022 Thanks to COVID-19 online shopping has catapulted in popularity. Subsequently, so has the Buy Now Pay Later (BPNL) universe. But, with so many BPNL players in the industry, which one do you choose? Size does matter and reach is paramount for merchants who want to offer a range of payment providers but must nearly always include bigger players like PayPal. PayPal wins for merchants and many purchasers because: 1. PayPal has 396 million customers 2. PayPal processes approximately 60% of all online retail spending (ex-China) 3. PayPal thrives without late fee income unlike most competitors 4. PayPal is already indirectly in the Chinese market via Go Pay and Shanghai-based Union Pay with potential to reach 500 million Chinese shoppers 5. Information Technology Resources - PayPal launched its BNPL response far quicker than any smaller player could imagine Merchants don't want a window full of logo stickers for payment providers and Millennials are too savvy to have a phone full of BNPL apps. They want proven providers when managing their money and money transfers. Other Global Tech stocks/themes include: NVDIA, Amazon, VISA, Apple Pay, Nintendo, Hydrogen, and Low Emission energy.
Insync's investment strategy concentrates on disruption and its interrelationship with a global Megatrend rather than just investing in disruptive companies. Our investment philosophy revolves around high quality companies. We look for companies that are benefiting from disruption, have long runways of growth through exposure to global Megatrends and are highly profitable. Funds operated by this manager: Insync Global Capital Aware Fund, Insync Global Quality Equity Fund Disclaimer |
11 May 2022 - Performance Report: Airlie Australian Share Fund
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| Fund Overview | The Fund is long-only with a bottom-up focus. It has a concentrated portfolio of 15-35 stocks (target 25). The fund has a maximum cash holding of 10% with an aim to be fully invested. Airlie employs a prudent investment approach that identifies companies based on their financial strength, attractive durable business characteristics and the quality of their management teams. Airlie invests in these companies when their view of their fair value exceeds the prevailing market price. It is jointly managed by Matt Williams and Emma Fisher. Matt has over 25 years' investment experience and formerly held the role of Head of Equities and Portfolio Manager at Perpetual Investments. Emma has over 8 years' investment experience and has previously worked as an investment analyst within the Australian equities team at Fidelity International and, prior to that, at Nomura Securities. |
| Manager Comments | The Airlie Australian Share Fund has a track record of 3 years and 11 months and therefore comparison over all market conditions and against its peers is limited. However, the fund has outperformed the ASX 200 Total Return Index since inception in June 2018, providing investors with an annualised return of 12.32% compared with the index's return of 9.57% over the same period. On a calendar year basis, the fund hasn't experienced any negative annual returns in the 3 years and 11 months since its inception. Over the past 12 months, the fund's largest drawdown was -6.79% vs the index's -6.35%, and since inception in June 2018 the fund's largest drawdown was -23.8% vs the index's maximum drawdown over the same period of -26.75%. The fund's maximum drawdown began in February 2020 and lasted 9 months, reaching its lowest point during March 2020. The fund had completely recovered its losses by November 2020. The Manager has delivered these returns with 0.5% less volatility than the index, contributing to a Sharpe ratio which has only fallen below 1 once over the past three years and which currently sits at 0.79 since inception. The fund has provided positive monthly returns 97% of the time in rising markets and 13% of the time during periods of market decline, contributing to an up-capture ratio since inception of 106% and a down-capture ratio of 92%. |
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11 May 2022 - Performance Report: ASCF High Yield Fund
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| Fund Overview | Does not require full valuations on loans <65% LVR. Borrowing rates are from 12% per annum on 1st mortgage loans and 16% per annum on 2nd mortgage/caveat loans. Pays investors between 5.55% - 6.25% per annum depending on their investment term. |
| Manager Comments | The ASCF High Yield Fund has a track record of 5 years and 2 months and has outperformed the Bloomberg AusBond Composite 0+ Yr Index since inception in March 2017, providing investors with an annualised return of 8.66% compared with the index's return of 1.59% over the same period. On a calendar year basis, the fund hasn't experienced any negative annual returns in the 5 years and 2 months since its inception. Over the past 12 months, the fund hasn't had any negative monthly returns and therefore hasn't experienced a drawdown. Over the same period, the index's largest drawdown was -10.02%. Since inception in March 2017, the fund's largest drawdown was 0% vs the index's maximum drawdown over the same period of -10.29%. The Manager has delivered these returns with 3.76% less volatility than the index, contributing to a Sharpe ratio which has consistently remained above 1 over the past five years and which currently sits at 23.64 since inception. The fund has provided positive monthly returns 100% of the time in rising markets and 100% of the time during periods of market decline, contributing to an up-capture ratio since inception of 87% and a down-capture ratio of -79%. |
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11 May 2022 - Performance Report: 4D Global Infrastructure Fund
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| Fund Overview | The fund is managed as a single portfolio including regulated utilities in gas, electricity and water, transport infrastructure such as airports, ports, road and rail, as well as communication assets such as the towers and satellite sectors. The portfolio is intended to have exposure to both developed and emerging market opportunities, with country risk assessed internally before any investment is considered. The maximum absolute position of an individual stock is 7% of the fund. |
| Manager Comments | The 4D Global Infrastructure Fund has a track record of 6 years and 2 months and has outperformed the S&P Global Infrastructure TR (AUD) Index since inception in March 2016, providing investors with an annualised return of 9.7% compared with the index's return of 9.16% over the same period. On a calendar year basis, the fund has only experienced a negative annual return once in the 6 years and 2 months since its inception. Over the past 12 months, the fund's largest drawdown was -3.9% vs the index's -0.57%, and since inception in March 2016 the fund's largest drawdown was -19.77% vs the index's maximum drawdown over the same period of -24.67%. The fund's maximum drawdown began in February 2020 and has lasted 2 years and 2 months, reaching its lowest point during September 2020. The Manager has delivered these returns with 0.54% less volatility than the index, contributing to a Sharpe ratio which has fallen below 1 four times over the past five years and which currently sits at 0.77 since inception. The fund has provided positive monthly returns 96% of the time in rising markets and 14% of the time during periods of market decline, contributing to an up-capture ratio since inception of 99% and a down-capture ratio of 96%. |
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11 May 2022 - Seeking predictable returns during economic turmoil
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Seeking predictable returns during economic turmoil Laureola Advisors April 2022 Continuing Instability, More War; Credit Excesses. The war in the Ukraine continues with shocking humanitarian suffering and carnage not seen in Europe in 8 decades. The ongoing war and related sanctions will likely lead to sustained inflation, more market instability and heightened geo-political uncertainties. The reaction of the Russian leadership to any failure on the ground cannot be predicted. In China, an outbreak of Covid has led to strict lockdowns, with the inevitable economic downturn and possible social unrest. China has her own deflating financial bubble, primarily in real estate: the yields on major Chinese Developers ranged from 15.5% (Country Garden) to 109% (Evergrande). Excess credit leads to instability in all countries. Real world inflation continues to be an issue - another outcome of credit excess exacerbated by war, Covid and supply-chain problems. Many commodity prices are up double digits, wages are up, and central banks appear to be starting a tightening cycle: the first since 1994, nearly 30 years ago. Most Fund Managers will be seeing one for the first time. Investors must contemplate multiple scenarios, including current inflation, credit instability, rising default rates, and probable deflation in financial assets. Inflation and Life Settlements. Should Life Settlements be part of investors' portfolios in times of inflation? A rational analysis will begin by establishing three assumptions: expected return on the LS portfolio, expected inflation, and the time horizon. The expected return of the Laureola LS strategy is 8% to 12%; the actual return in the past few years has been between 6% and 9%. At least this has the validity of being backed by realised gains.
Mathematically, a 7% return will be helpful, even in a 4% inflation environment. Investors can adjust both figures according to their analysis, but there is a significant buffer. Despite the fixed income characteristics, LS prices are only modestly correlated to interest rates. The IRRs on LS have ranged between 6% and 12% above Treasuries and LS prices have proven to be more dependent on capital flows and liquidity. The prices of LS may vary over the coming 5 years, but the realised return on those already purchased will not be affected. The realised return on LS is reliant primarily on getting the mortality right, and that is why Laureola has such a strong focus on understanding the mortality of each insured. Control for this variable will beat inflation in most scenarios. Performance and positioning Investors are concerned about the effects of inflation on their portfolios. There is no doubt a place for assets that directly protect against inflation, such as commodity exposure, real estate, or possible gold. But a portfolio focussed only on these assets may not do well in other scenarios, e.g. more moderate inflation or deflation resulting from a credit crisis. A stable 7% annual return over 5 years will provide investors with 40% more purchasing power 5 years from now. Laureola has always delivered 7% or better over 5 years and, as the strategy is based on mortality, it brings the added benefits of genuine non-correlation, stability and protection from geo-political and economic shocks. Funds operated by this manager: |
10 May 2022 - Performance Report: Quay Global Real Estate Fund (Unhedged)
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| Fund Overview | The Fund will invest in a number of global listed real estate companies, groups or funds. The investment strategy is to make investments in real estate securities at a price that will deliver a real, after inflation, total return of 5% per annum (before costs and fees), inclusive of distributions over a longer-term period. The Investment Strategy is indifferent to the constraints of any index benchmarks and is relatively concentrated in its number of investments. The Fund is expected to own between 20 and 40 securities, and from time to time up to 20% of the portfolio maybe invested in cash. The Fund is $A un-hedged. |
| Manager Comments | The Quay Global Real Estate Fund (Unhedged) has a track record of 6 years and 4 months and has outperformed the BBAREIT Index since inception in January 2016, providing investors with an annualised return of 8.67% compared with the index's return of 6.6% over the same period. On a calendar year basis, the fund has only experienced a negative annual return once in the 6 years and 4 months since its inception. Over the past 12 months, the fund's largest drawdown was -8.21% vs the index's -11.14%, and since inception in January 2016 the fund's largest drawdown was -19.68% vs the index's maximum drawdown over the same period of -23.56%. The fund's maximum drawdown began in February 2020 and lasted 1 year and 4 months, reaching its lowest point during September 2020. The fund had completely recovered its losses by June 2021. The Manager has delivered these returns with 0.47% more volatility than the index, contributing to a Sharpe ratio which has fallen below 1 three times over the past five years and which currently sits at 0.68 since inception. The fund has provided positive monthly returns 73% of the time in rising markets and 36% of the time during periods of market decline, contributing to an up-capture ratio since inception of 68% and a down-capture ratio of 60%. |
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10 May 2022 - Facts are stubborn, but statistics are more pliable
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"Facts are stubborn, but statistics are more pliable" - Mark Twain FundMonitors.com May 2022 In some analyst's eyes Tracking Error, which measures how closely a fund follows its benchmark index, provides a useful way of measuring both a fund's performance, and value against the index. It is calculated as the standard deviation of the difference between the returns of an investment (or fund) and its benchmark. The theory is that the more active the fund the higher its performance should be compared with the benchmark, and therefore the higher its tracking error should be. Conversely, the lower the Tracking Error, the more closely the fund follows the index. The logic seems straightforward enough: Investors in active funds, and paying "active" fees, don't want to pay the fund manager to simply track the index. Unfortunately the Tracking Error can be a misleading way to evaluate a manager's performance. A more informative way to look at a fund's performance vs its underlying benchmark or index is to measure its Up and Down Capture Ratio. Once understood, they provide a more realistic measurement of a fund's ability to perform in both positive and negative markets. The up capture ratio shows the percentage of the market's gains the fund has captured when the market rises. The higher the up capture ratio, the better the fund has performed in positive markets. Conversely, the down capture ratio shows the percentage of the market's losses the fund captures when the market falls. The lower the down capture ratio, the better the fund's performance in negative markets. So far so good! However, selecting funds based on their relative up and down capture ratios will also be dependent on the investor's circumstances (age, life cycle), risk tolerance and one's market expectations. Down Capture is particularly useful as it indicates the fund's ability to protect capital in falling markets. If an investment loses 20% it needs to gain 25% just to get back to where it started, and if it loses 40%, it needs a return of 66.7% to get back to even. As an example, the Collins St Value Fund and the DS Capital Growth Fund both appear in their peer group's highest performance quintile over 3 and 5 years. This is primarily based on their low down capture ratios of 47.6% and 70.5% respectively. Similarly the Bennelong Australian Equities Fund was also in the highest performance quintile, but based on a high up capture of 131.7%. Importantly both DS Capital and Bennelong had low tracking errors compared to the respective peer group. The L1 Capital Global Opportunities Fund returned an impressive 35.51% per annum for the past 5 years by not having a negative return in any month, resulting in a negative down capture ratio of -131%, while also having a relatively low Tracking Error of 11.5. For most Advisers and Investors it is easy to get lost in a sea of often contradictory statistics that potentially don't tell the full story. It is better to have a high level of diversification, and to concentrate on those statistics that are aligned to your investment goals - whether that be protecting the downside, or making hay while the sun shines! |
10 May 2022 - Powell seeks 'immaculate disinflation'; one that rids the US of inflation without shedding jobs
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Powell seeks 'immaculate disinflation'; one that rids the US of inflation without shedding jobs Magellan Asset Management April 2022
Federal Reserve Chair Jerome Powell appeared on March 3 before the Senate Banking Committee and vowed the US central bank would quell inflation running at four-decade highs. "We are going to use our tools," he said. Then came a pointed question. Would the Fed be prepared to harm the economy to tame inflation? To show his intent to smother inflation that has surged to 8.5% (12 months to March), Powell answered "yes" by invoking the last Fed chief to induce a recession to rein in price rises. The Jimmy Carter-appointed Paul Volcker, who was Fed chair from 1979 to 1987, raised the key rate so much - to 20% in 1981 - he triggered two recessions; a fleeting one in 1980 and the slump of 1981-1982 when the jobless rate peaked at a then-post-Depression high of 10.8%.[1] "I knew Paul Volcker," Powell said. "I think he was one of the great public servants of the era."[2] Volcker was probably the most hated.[3] As the economy slumped, the Fed was subject to protests that still rate the greatest in its history. In-debt farmers on tractors besieged Fed headquarters while car dealers sent coffins full of unsold car keys.[4] Volcker was assigned bodyguards,[5] especially as a man angry at high rates and armed with a sawed-off shotgun burst into Fed HQ.[6] While Volcker was scorned by industry, the public and politicians (but not the media - why Ronald Reagan reappointed Volcker in 1983), historians have been kind. "Volcker was Jimmy Carter's gift to Reagan," one Reagan biographer wrote. Volcker "squeezed the inflationary expectations out of the economy and put it on the path to solid growth".[7] Powell says he can achieve the same feat without the Volcker recession(s). He'd better. Though Volcker was on the Fed leadership team from 1975, he bore little responsibility for how inflation was running at 13% when he became Fed chair. (It peaked at 14.8% in early 1980.) Powell, however, is to blame for much of today's inflation for two reasons. The first is Powell loosened the Fed's inflation guidelines. The Fed in 2020 scrapped a 2% inflation ceiling that had been in place unofficially then since 2012 officially for two decades in favour of an average target of 2%. The change means the Fed will let inflation exceed 2% "for some time" if it has undershot that figure. The move signalled the Fed would refrain from taking pre-emptive steps against inflation. It makes inflationary expectations prone to leaps.[8] Powell's other error - one he admits to[9] - was to misdiagnose today's inflation as fleeting.[10] Even though inflation has topped 5% since mid-last year by when unemployment had fallen below 6%, the Fed left untouched a record low US cash rate and persisted with its asset purchases until March this year. The Fed was even purchasing mortgage-backed securities when home prices, which eventually feed into inflation gauges, were soaring at a 20% clip.[11] Powell's major fightback against inflation kicked off on March 16 when the Fed raised the cash rate by 25 basis points to a range of 0.25% to 0.5%. Powell's other anti-inflation tool is to shrink the Fed's US$8.9 trillion balance sheets swollen by quantitative easing. Such asset sales would boost longer-term bond yields. Powell's third weapon is to talk tough, as he did on March 21 when he said the Fed would raise the key rate "by more than 25 basis points at a meeting or meetings" to beat inflation.[12] On the day the Fed raised the cash rate, Fed policy-setting board member 'projections' showed they expect to authorise another 11 rate increases of 25 basis points by the end of 2023 that would lift the key rate to 2.8%. Such an outcome would mean the key rate would be below the Fed's inflation projections until the end of 2023.[13] The Fed thus thinks it can douse inflation with negative real rates while the economy will "flourish" in Powell's words[14] and unemployment stays at generational lows. The jobless rate stood at 3.8% in February. Such thinking contradicts how the Fed's economic models assume a trade-off between inflation and employment. Michael Feroli, chief US economist at J.P.Morgan, ridiculed the Fed's forecasts as "magical, immaculate disinflation".[15] The models on which the Fed bases policy decisions are Keynesian-based ones[16] where policymakers seek to manipulate demand to influence inflation, employment and economic growth.[17] Powell's biggest problem is the US economy is not just overheating due to excessive demand (due to fiscal and monetary stimulus). The economy is suffering from 'supply shocks' beyond the reach of monetary policy that fan inflation while denting growth. Count these shudders. Russia's attack on Ukraine has boosted energy, food and metal prices and reduced consumer spending on other items. The West's sanctions against Russia will hasten the reversal of the globalisation that exploited cheap foreign labour to reduce the cost of goods. China's recent lockdown is just the latest to constrain the output of 'the world's factory' and elsewhere. The pandemic-inspired 'reshoring' of production since 2020 has caused shortages. Lockdown populations, deprived of services but flush with fiscal stimulus, bought goods in such quantities that ports, ships, trains and trucks couldn't cope. Populations detained at home boosted demand for technology so much a shortage of microchips is hobbling the production of many goods. A shift to renewable energy is causing 'greenflation', the term for when the supply of fossil fuels falls but demand doesn't. Pandemic-inspired resignations and the decline of working-age populations tied to falling birth rates are pushing up wages (by 6% in the US).[18] Powell's best hope is the supply shocks ease and inflation recedes without the Fed needing to raise rates. This is the "soft landing" of the Fed projections that Powell says the Fed pulled off in 1965, 1984 and 1994.[19] Next best, Powell might permit moderate inflation and hope to avoid a cost-of-living blowout that would result in stagflation. An option if inflation persists? Powell might have to crush the economy. Ultimately, a credible Fed chair must mimic Volcker. To be sure, some excess demand the Fed can stifle is boosting US inflation. But how to remove surplus demand without strangling an economy recovering from the covid-19 blows? Hard to calibrate. How much demand would need to be eliminated to tame inflation boosted by supply constraints? Too much. The soft landings Powell cited aren't much solace because in these cases the Fed stopped inflation accelerating, rather than hauled it in.[20] The US economy could enter a downturn irrespective of what the Fed does, if events were to so turn (due to, say, Russian cyberattacks, a sovereign debt crisis in the eurozone or the developing world or covid-22). In an era of record debt and bloated asset markets, Powell need not raise the US cash rate to the level Volcker did to slow economic growth.[21] But Powell surely needs to do more than the Fed projections suggest. In the balance between aiming for price stability and full employment, the Fed seeking to hold its authority and independence will eventually need to prioritise fighting inflation to keep the trust that Volcker earned against much hostility. Sidelined central bankers Charles Goodhart (born 1936) is a UK economist who has split much of his career between the Bank of England and the London School of Economics.[22] Last year, Goodhart predicted that by 2021 higher inflation would become entrenched. Why? Low birth rates and the consequential decline in working-age populations are ending the era of cheap labour and affordable goods. A future of faster inflation (3% to 4% compared with 1.5%) beckons. In the meantime, Goodhart predicted labour shortages, fiscal stimulus and the post-pandemic recovery meant inflation would hit "between 5% and 10% in 2021 - and stay high."[23] Which is what's happened in the eurozone (inflation at 5.9%), the UK (6.2%) and the US. Goodhart, co-author of The great demographic reversal book released in 2020, is correct that the labour pool in many countries (from China to Germany) is shrinking as the world heads towards its first voluntary depopulation. Whether such a wage-boosting shift is driving today's inflation is arguable. What is clearer is that monetary policy is largely powerless to tackle such inflation, short of a Volcker-destroy-the-economy setting that no one wishes to seek. Same goes for greenflation. Global efforts to curb the use of fossil fuels, such as Biden's decisions to halt fracking on federal land and block a key oil pipeline from Canada to the US, have helped propel benchmark oil and gas prices. Central banks struggle to ease greenflationary pressures without inducing a downturn that, among other harm, could slow the investment in renewables they seek to promote. The end of the second great era of globalisation will probably be dated to when the pandemic struck in 2020. Shortages of emergency goods prompted governments to order home the manufacturing of essential medicines and supplies. Lockdowns, especially those in China, that interrupted the production of everything from microchips to car parts motivated firms to rejig supply lines. Russia's invasion of Ukraine in February only further prioritised national security and self-reliance over economic efficiency. The sanctions imposed on Russia, the strictest ever inflicted on a large economy, are inspiring Moscow to seek revenge (the closing of a key oil pipeline and demands European countries pay in rubles for gas), which further boosts energy prices.[24] The sanctions could come with unintended blows for the global economy and, longer term, might encourage autocracies to become less reliant on the US-led financial order. What can monetary policy do to help alleviate inflationary pressures as ties between blocs fade? Not much. Higher interest rates could even be harmful if they slow investment that could relieve shortages. Wars usually cause inflation because production is interrupted, transport is disrupted, resources are diverted, young workers are deployed to the military and many are killed and maimed, civilians are killed and become refugees as they flee battlegrounds, and capital goods are destroyed.[25] The OECD in March said the war in Ukraine is likely to lop more than 1 percentage point from global economic growth this year while lifting world inflation by 2.5 percentage points.[26] (Late 2021, the OECD predicted the global economy would expand by 4.5% this year while consumer prices would rise by 4.2%.) Successful peace talks would dampen inflation pressure far more than any action central bankers could take. China's latest lockdown has only added to policymaker angst about hampered supply. How can central banks tackle inflation stemming from health restrictions without damaging the economy? They can't. In a world where supply constraints are driving up prices, central banks must choose between inflation and growth (especially in the absence of politically led appropriate solutions to supply-side inflation such as using fiscal policy instruments (taxes and transfers), microeconomic reforms, industry policy, trade policy and diplomacy (in the case of the Ukraine war, and a better health response in the case of China and covid-19). Two big differences between Volcker's world and that of today are the mammoth increase in debt (government, corporate and household) and the financialisation of the global economy that means asset markets hold larger sway over the economy. The marginal impact of each increase in interest rates is greater, especially if asset prices are stretched. In any Powell blitz against inflation, the cash rate won't have to increase as much as some people might think to trigger a Volcker-like bludgeoning of the economy. Author: Michael Collins, Investment Specialist |
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Funds operated by this manager: Magellan Global Fund (Hedged), Magellan Global Fund (Open Class Units) ASX:MGOC, Magellan High Conviction Fund, Magellan Infrastructure Fund, Magellan Infrastructure Fund (Unhedged), MFG Core Infrastructure Fund [1] National Bureau of Economic Research. 'US business cycle expansions and contractions.' nber.org/research/data/us-business-cycle-expansions-and-contractions. The jobless rate peaked at 10.8% in November and December of 1982. See US Bureau of Labor Statistics. 'Top picks.' data.bls.gov/cgi-bin/surveymost. The jobless rate reached 14.7% in April 2020 when the pandemic struck. [2] 'The Fed chair pledges to bring inflation under control and signals wariness on wages.' The New York Times. 3 March 2022. nytimes.com/2022/03/03/business/economy/federal-reserve-powell-inflation.html [3] Then treasury secretary Dan Regan described Volcker as possessing "almost a messianic desire" to kill inflation, H.W. Brands. 'Reagan. The life.' Anchor Books. 2015 edition. Page 318. [4] Federal Reserve History. 'Volcker's announcement of anti-inflation measures.' Written as of 22 November 2013. federalreservehistory.org/essays/anti-inflation-measures [5] Sebastian Mallaby. 'The man who knew. ' Bloomsbury Publishing. 2016. Page 367. [6] 'Paul A Volcker, Fed chairman who curbed inflation by raising interest rates, dies at 92.' Washington Post. 9 December 2019. washingtonpost.com/local/obituaries/2019/12/09/c744d596-1468-11e1-9048-1f5352187eed_story.html [7] Brands. Op cit. Page 736. [8] Federal Reserve. Media release. 'Federal Open Markets Committee announces approval of updates to its statement on longer-run goals of monetary policy strategy.' 27 August 2020. federalreserve.gov/newsevents/pressreleases/monetary20200827a.htm [9] At the media conference on the day the Fed announced its rate increase, Powell answered a reporter's questions by saying with the benefit of hindsight "it would have been appropriate to move earlier". Federal Reserve. 'Transcript of Chair Powell's press conference March 16, 2022.' Page 26. federalreserve.gov/mediacenter/files/FOMCpresconf20220316.pdf [10] History will mark the tightening as occurring in November 2021 when the Fed first reduced its asset purchases. [11] The shelter index gains of 0.5% in February accounted for more than 40% of the jump in core inflation (ex-energy and ex-food) that month. [12] Jerome Powell, Fed chair speech. 'Restoring price stability.' 21 March 2022. federalreserve.gov/newsevents/speech/powell20220321a.htm. The last time the Fed raised the key rate by half a percentage point was in May 2000. [13] The inflation readings of 4.3% at end 2022 and 2.7% at end 2023 are the Fed's preferred measure of personal-consumption expenditure, which is usually lower than the consumer-price index. Federal Reserve media release. 'Federal Reserve Board and Federal Open Market Committee release economic projections from the March 15-16 FOMC meeting.' 16 March 2022. federalreserve.gov/newsevents/pressreleases/monetary20220316b.htm [14] Federal Reserve. 'Transcript of Chair Powell's press conference March 16, 2022.' Page 5. federalreserve.gov/mediacenter/files/FOMCpresconf20220316.pdf [15] Mike Feroli, chief US economist at J.P.Morgan, was quoted in an article in The New York Times. 'Fed raises rates and projects six more increases in 2022.' 16 March 2022. nytimes.com/live/2022/03/16/business/fed-meeting-interest-rates#fed-raises-interest-rates. Former Barack Obama treasury secretary Larry Summers, who forecast Joe Biden's stimulus would stir inflation, dismissed the Fed projections as "delusional". See Larry Summers. 'The stock market liked the Fed's plan to raise interest rates. It's wrong.' The Washington Post. 17 March 2022. washingtonpost.com/opinions/2022/03/17/larry-summers-fed-interest-rates-inflation/ [16] The Fed main model is the FRB/US general equilibrium model that it has used since 1996. See Federal Reserve. 'FRB/IS Model.' Last updated 9 November 2021. federalreserve.gov/econres/us-models-about. [17] The models include the Philips Curve that seeks to spot when a tight labour market threatens to ignite a wages-price spiral. [18] Federal Reserve Bank of Atlanta. 'Wage growth tracker.' Three-month moving average of median wage growth, hourly data. Tracker reading for February shows wages rising 5.8%. atlantafed.org/chcs/wage-growth-tracker [19] Jerome Powell, Fed chair speech. 'Restoring price stability.' Op cit. federalreserve.gov/newsevents/speech/powell20220321a.htm [20] See Greg Ip. Capital account. 'The Wall Street Journal.' 23 March 2022. wsj.com/articles/the-odds-dont-favor-the-feds-soft-landing-11648045029 [21] There is a theoretical debate to be had as to whether inflation is such a menace it needs to be crushed at any cost. Economies that install proper indexation (such as Hong Kong in the 1990s) show it's not. But the US economy, especially the labour market, is never that organised. [22] See 'Lifetime achievement: Charles Goodhart.' 17 March 2021. centralbanking.com/awards/7807336/lifetime-achievement-charles-goodhart [23] 'Will inflation stay high for decades? One influential economist says yes.' The Wall Street Journal. 9 March 2022. wsj.com/articles/inflation-high-forecast-economist-goodhart-cpi-11646837755 [24] European gas prices soared 30% on the day Russia demanded payments in rubles. Bloomberg News. 'Putin demands ruble payment for gas, escalating energy fight.' 23 March 2022. bloomberg.com/news/articles/2022-03-23/putin-wants-hostile-states-to-pay-rubles-for-gas-interfax-says [25] IMFBlog. 'How war in Ukraine is reverberating across world's regions.' 15 March 2022. blogs.imf.org/2022/03/15/how-war-in-ukraine-is-reverberating-across-worlds-regions/ [26] OECD. 'Economic and social impacts and policy implications of the war in Ukraine.' OECD Economic Outlook, Interim Report March 2022. oecd-ilibrary.org/sites/4181d61b-en/index.html Important Information: This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 ('Magellan') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation. This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should read and consider any relevant offer documentation applicable to any investment product or service and consider obtaining professional investment advice tailored to your specific circumstances before making any investment decision. A copy of the relevant PDS relating to a Magellan financial product or service may be obtained by calling +61 2 9235 4888 or by visiting www.magellangroup.com.au. Past performance is not necessarily indicative of future results and no person guarantees the future performance of any strategy, the amount or timing of any return from it, that asset allocations will be met, that it will be able to be implemented and its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of a Magellan financial product or service may differ materially from those reflected or contemplated in such forward-looking statements. This material may include data, research and other information from third party sources. Magellan makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Magellan. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. 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9 May 2022 - Performance Report: DS Capital Growth Fund
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| Fund Overview | The investment team looks for industrial businesses that are simple to understand, generally avoiding large caps, pure mining, biotech and start-ups. They also look for: - Access to management; - Businesses with a competitive edge; - Profitable companies with good margins, organic growth prospects, strong market position and a track record of healthy dividend growth; - Sectors with structural advantage and barriers to entry; - 15% p.a. pre-tax compound return on each holding; and - A history of stable and predictable cash flows that DS Capital can understand and value. |
| Manager Comments | The DS Capital Growth Fund has a track record of 9 years and 4 months and has outperformed the ASX 200 Total Return Index since inception in January 2013, providing investors with an annualised return of 14.25% compared with the index's return of 9.58% over the same period. On a calendar year basis, the fund has only experienced a negative annual return once in the 9 years and 4 months since its inception. Over the past 12 months, the fund's largest drawdown was -10.9% vs the index's -6.35%, and since inception in January 2013 the fund's largest drawdown was -22.53% vs the index's maximum drawdown over the same period of -26.75%. The fund's maximum drawdown began in February 2020 and lasted 6 months, reaching its lowest point during March 2020. The fund had completely recovered its losses by August 2020. The Manager has delivered these returns with 1.97% less volatility than the index, contributing to a Sharpe ratio which has fallen below 1 four times over the past five years and which currently sits at 1.1 since inception. The fund has provided positive monthly returns 89% of the time in rising markets and 35% of the time during periods of market decline, contributing to an up-capture ratio since inception of 66% and a down-capture ratio of 55%. |
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